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Essentials of Monetary Policy

The ECB Cuts Rates Again While Making Changes to Its Operational Framework

September 12, 2024
Hendrix Vachon
Principal Economist

European Central Bank (ECB)

  • The Governing Council decided to lower the deposit facility rate by 25 basis points. The spread between the interest rate on the main refinancing operations and the deposit facility rate will be set at 15 basis points. The spread between the rate on the marginal lending facility and the rate on the main refinancing operations will remain unchanged at 25 basis points. Accordingly, the deposit facility rate will be decreased to 3.50%. The interest rates on the main refinancing operations and the marginal lending facility will be reduced to 3.65% and 3.90%, respectively.
  • The ECB's inflation projections haven't changed since June. Inflation is expected to total 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026.
  • Excluding energy and food, projected inflation for 2024 and 2025 has been revised slightly upward due to higher−than−expected services inflation. The ECB sees core inflation coming in at 2.9% this year, 2.3% in 2025 and 2% in 2026.
  • Meanwhile, projected economic growth has been revised downward by a tenth of a percentage point each year, mostly because of weaker-than-expected domestic demand. That takes the current forecasts for real GDP growth down to 0.8% in 2024, 1.3% in 2025 and 1.5% in 2026.

Comments

The main refinancing operations rate used to be our indicator for where eurozone monetary policy is going. But that rate ceases to be meaningful when the money market is flooded with excess liquidity. The deposit facility rate has become the main benchmark for the eurozone's money market. The ECB's changes to its operational framework reflect this new reality. Other central banks have made similar changes to their operational frameworks, including the Bank of Canada, which sets its target for the overnight rate to be equal to the deposit rate. The ECB has decided that the spread between its deposit rate and its main refinancing operations rate will be set at 15 basis points.

 

The central bank's decision to lower its key rate by 25 basis points was widely expected. After an initial rate cut in June, the ECB decided to pause in July due to a belief that some indicators called for caution. The latest inflation figures showed headline inflation falling again, but core inflation, which strips out food and energy, remained unchanged (graph 1). One of the ECB's main concerns is services inflation, which is strongly correlated with wage growth. But the good news is that recent indicators show wage growth cooling (graph 2).  The ECB expects this trend to continue, which should help rein in services inflation in 2025. The job market also shows signs of slackening, which should help bring wages under control. Furthermore, the ECB is reassured by the fact that companies are tightening their profit margins to absorb some of the rise in labour costs. It believes these trends will remain in place in the coming years.

 

Productivity was a major topic of discussion during the press conference that followed the monetary policy meeting. Former ECB president Mario Draghi recently released a report that suggested ways to improve eurozone productivity. The ECB assumes productivity will ramp up gradually, which will help reduce inflation.

Implications

The ECB is refusing to make any promises about its interest rate trajectory. The ECB's current president, Christine Lagarde, has nevertheless admitted that the trend will likely be downward, which is no surprise. But we get the impression that the ECB remains cautious about inflation. It just doesn't seem to have the breathing room to focus more on the economy, unlike the Federal Reserve and the Bank of Canada. Consequently, we don't believe rates will be lowered as quickly in Europe as in the United States. For now, a 50‑basis‑point cut by the ECB seems highly unlikely anytime soon. In fact, the central bank may even decide that additional pauses in its rate-cutting cycle are needed.

2024 Schedule of Central Bank Meetings

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